In hindsight I was much too bearish at on May 20, 2010. The market had already come down very hard and was approaching a retest of the May, 6 2010 mini crash low. The relative strength index was already at 30.
I was too emotional and too bearish. I was giving a lot of credit to the fact that we were in a powerful downtrend since the reaction rally and also giving too much credit to the strong chance of a follow on crash scenario. I was counting on a downward break of the 30 RSI level leading to a super plunge that would break the May 6, 2010 low and turn into a panic.
When the market gapped down on Friday I was watching the tape and I was specifically looking for fairly immediate follow through to confirm further weakness. But the market was resistant and then the rally came, sold off and rallied again several times, but was never really able to get enough downside follow through.
The warning sign was the opening gap. When I saw the opening gap I thought the market could rally back up to fill the gap and then continue down again. It did fill the gap, but then it never was able to show weakness again.
The gap down was an exhaustion move and the previous strong negative candle was a warning sign that we could be close to exhaustion.
The fact that we closed strongly higher this past Friday on very heavy volume and in many cases engulfed the previous days candle almost completely on many stocks and a few indices further seems to show that we have hit bottom here.
The US Dollar Index looks overdue for a pullback based on my read of the charts and the Euro could get a rally going. That might be enough to get a good bounce going in the equity markets.
A bunch of commodities are oversold as well and further evidence that an extended bounce is overdue.
This was a successful retest in my opinion. And it was on lighter but still relatively heavy volume. So for now I do not see us getting a successful break down yet. This was the second try and a retest.
I do think we will be successful on the third try as is often the case with many stocks and indices. The magic number of three.
Anyway for those of you still interested in the 1987 2010 patterns here is another chart that I drew up. I have to be very careful about creating the expectation that the market will once again do like it did in 1987. It would seem like it could happen but the only way it will ever happen is if the market gets to another strong overbought stage again and then at a VERY SPECIFIC moment in time start falling with an almost unbelievable relentless persistence as it did after the final reaction rally off of the double bottom in October 1987.
Assuming we do now get a strong reactionary rally higher I want to see it move higher on lower and lower volume and push the market higher to the limit to get the RSI overbought again.
THEN AND ONLY THEN will I be looking for a defining sign of weakness that would potentially kick off another persistent wave of selling. If I see that then I will heavily short this market. The best time to short as at the peak of market strength, not in the middle or later stages of a decline.
If the market is able to get a marginal new high above 1170 it would completely screw up all the bearish elliott wave counts !
The key really is how much of a rally we get going here. There is not much wiggle room. What made the 87 experience so vicious was that the final rally after the W bottom broke northward out of the downtrend line! And so it probably had people relaxed that new highs were ahead and the worse was over.. but it was just beginning.
This is why the MOST DEVIANT thing this market can do is rally slightly above 1170 and break the downtrend line that is currently in force from the April 2010 52 week highs.
Whether or not that happens remains to be seen…
But for now we rally…
Tom,
Another great update from you.
Crash on May6 was more because, EUROZONE banks were freezing lending. there was little cash in the market. Traders panicked and sold off fearing another Lehman style scenerio.
At the moment, there is no such thing as “Lending Freeze” among banks. I agree with you that next week or two could be dull. However, I think, S&P will not cross 1124 intraday and 1114 on closing basis. At S&P 1118, I will short, let us see how it goes. Usually, I make a mistake of shorting little earlier, hope not this time…..
Days before, I shorted perfect at 1147.3 (and S&P turned at 1148) but covered at 1118.6 only to see it going down to 1056 in two days.
Thanks for excellent update.
Thanks for your comments. Indeed it seems like a rally is due. Interesting that you think no higher than 1124. That would be consistent the the current waterfall decline type pattern we have going on here. It should be an interesting week.
Tom — I am a newcomer to your blog, I have been watching your comments for the past couple of weeks. Just want to say well done, overall you have been writing some really good stuff. Keep up the good work..
Thanks for your comment. Welcome aboard !